Knee-jerk reaction to U.S. oil decision is overdone
By MATHEW INGRAM
Globe and Mail Update
The United States government has decided to release 30 million barrels of oil from its petroleum reserves, and crude prices are tanking as a result — so investors should dump all their oil and gas stocks, right? That's certainly the message the market seems to be sending: at one point on Monday, the Toronto Stock Exchange oil and gas subindex had surrendered almost 250 points, or about 3 per cent of its value.
It's true that the price of crude, which threatened to touch the $40 (U.S.) a barrel mark last week, has had a substantial amount of fear built into it over the past six months or so — fear about OPEC's ability to supply more crude, fear about Iraq's sabre-rattling toward Kuwait, fear about U.S. petroleum stocks being at 24-year lows, and so on.
The announcement that Washington will be releasing 30 million barrels has taken some of that fear out of the futures markets, and as a result the price of crude has dropped back closer to the $30 level. The price of the October delivery contract hit $37.80 on the Nymex commodities exchange last week, and the new November contract sits at about $31.50.
But that doesn't necessarily mean all oil stocks are a massive "sell." Far from it. In fact, if the U.S. decision helps to stabilize the crude market, that can be good for producers. A stable price in the upper $20 range is far better for the industry than a price that is up in the stratosphere, but one which everyone agrees can't possibly last very long, because in the long run investors are looking for stability. From that point of view, the recent selloff could actually be positive.
You couldn't tell that by the market's reaction, however: Husky Energy was down close to 3 per cent at one point during the day Monday; Petro-Canada fell by more than 4 per cent; Canadian Natural Resources was off by 5 per cent; Talisman Energy lost almost 7 per cent; and Gulf Canada was down by close to 10 per cent. The TSE subindex fell by 3.3 per cent at one point, putting it back where it was in August.
Some market watchers said the release of crude from the U.S. Strategic Petroleum Reserve — 571 million barrels stored in vast salt caverns in Texas and Louisiana on the Gulf Coast — will simply remove some of the speculative "froth" that had pushed the price of crude futures up to the $39 level. "It will not bring a radically different situation but will fill in the gap in terms of market sentiment and remove panic," Bear Stearns' chief economist David Brown told Reuters on Monday.
"Given current oil inventories, we believe that the theoretical price for Brent should be around $27 — around $3 of the $6-$7 of froth has already been removed," Dresdner Kleinwort Benson said in a morning note. Banc of America analyst Tyler Dann said the selloff caused by weakening crude prices could make some stocks attractive. "Stronger-than-expected industry fundamentals should continue into 2001," he said.
The 30 million barrels that the United States is releasing from its reserves — only the second time it has done so (the first was in 1990, just before the Gulf war) — will come at a million barrels a day for a month. That may sound like a lot of oil, but it is still less than 5 per cent of the 20 million barrels that the United States uses up every day. It's also less than 1.5 per cent of the world's daily demand for crude.
The reaction to the U.S. decision also ignores some crucial facts about the current oil market: one is that refining capacity in the United States is close to its limit, with little space left to handle that one million extra barrels per day. All the U.S. move does is "buy a little time," Merrill Lynch analyst Michael Rothman told CNNfn. "That's because refining capacity in the U.S. and Europe is essentially maxed out right now... and frankly, the [U.S. crude release] doesn't address that particular problem."
In any case, even if the release of the 30 million barrels pushes crude back below the $30 level through the fall and into next year — as futures markets seem to indicate — the majority of oil and gas producers will continue to make plenty of cash. After the slump in 1998 that took crude to $10 a barrel, most of the majors cut their costs to the point where they can make substantial amounts of money anywhere above $18. Crude at $37 a barrel is pretty great, but things are still fine at $30 or even $25.
In other words, if the U.S. decision made you think that oil and gas stocks were no longer worth buying, think again.
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